Testimony: Palmer Schoening, Chairman, Family Business Coalition — U.S. Committee on Small Business & Entrepreneurship

Summary

Written testimony of Palmer Schoening, Chairman of the Family Business Coalition, addressed to Chair Shaheen, Ranking Member Ernst and members of the U.S. Committee on Small Business & Entrepreneurship on small business succession. The testimony describes the costs of succession planning and of converting to an employee stock ownership plan, which it puts at $50,000-$100,000 for a medium sized business. It urges making the 2017 Tax Cuts and Jobs Act changes permanent, supports eliminating the federal estate tax, and cites Tax Foundation figures of $18.9 billion in estate and gift tax compliance costs in 2023. It opposes eliminating step-up in basis and taxing unrealized capital gains. Figure 1 lists estate planning techniques with fee ranges, and Figures 2 and 3 concern state death taxes and federal estate tax returns by state.

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                                                                                         Palmer Schoening

                                                                      Chairman, Family Business Coalition

Chair Shaheen, Ranking Member Ernst, and Members of the U.S. Committee on Small Business &
Entrepreneurship: thank you for the opportunity to address the important topic of small business
succession here today. I currently serve as Chairman of the Family Business Coalition (FBC). Our mission
is to protect family owned and operated businesses across the country. Today I will discuss the
importance of family businesses to local communities, outline current policy proposals that affect the
ability of family businesses to pass to the next generation of ownership, and conclude by recommending
Congress adopt policy changes that make family business succession easier. The views in my testimony
here do not necessarily reflect the position of our Family Business Coalition member associations.

Family Businesses Create Jobs and Support Communities

Family businesses are the lifeblood of the American economy, providing good paying jobs and enriching
the lives of those in their communities. When a family business closes its doors, it is not only their
employees who suffer; it is the little league baseball team that the local family business sponsors, it is
the new wing of the children’s hospital being built with the support of local businesses that now has to
be put on hold, it is the soul of main street that withers away when family businesses are sold off to
multinational corporations or forced to close their doors for good.

The family businesses that we work with consider their employees to be family themselves. When times
get tough, both owners and employees tighten their belts to keep the business running. When times are
prosperous, the employees of family businesses are the first to benefit. At FBC, we have worked with
family businesses of all shapes and sizes including pass-throughs like s-corporations, privately held c-
corporations, and companies that are organized as ESOPs. As has been widely reported, the pandemic
accelerated a discouraging trend of increased small business closures and consolidation. The time is now
for Congress to make meaningful policy changes to prevent the closure and transfer of control of
America’s family-owned businesses into the c-suites of multinational corporations.

Family businesses and farms face a number of challenges when operating their businesses and planning
for the next generation including dealing with federal, state, and local taxes. Compliance with taxes and
regulations requires diverted time away from managing the day-to-day operations of a business. Most
family business owners specialize in running their businesses, not in legal paperwork. For many of these
family businesses, succession planning requires hiring expensive accountants, lawyers, and estate
planning attorneys. Even business owners that plan effectively must remain on their toes because of
constantly changing tax laws and regulations. All this diverted time, money, and energy could be better
directed towards growing their family businesses, upgrading equipment, hiring more workers, and
supporting their communities.

Figure 1 in my testimony, which lists common estate planning techniques and their associated fees,
illustrates just how expensive this succession planning can be. As an example, consider that according to
Figure 1, fees can range between $5,000-$15,000 to set up a simple trust. More sophisticated estate
planning for larger family businesses can cost hundreds of thousands of dollars. It is easy to see how
family farms or local mom and pop shops can be quickly overwhelmed by both the cost and time
required to plan for the next generation. Publicly traded corporations, on the other hand, have constant
access to outside experts, auditors, and dedicated accounting firms to assist with every aspect of their
compliance. In addition, among other advantages, these mega corporations also enjoy much easier
access to large pools of capital to finance their operations.

As it stands now, to pass on a family business or farm under current tax laws is an uphill battle and
serious reforms are needed to make this transition less painful. Members of this committee on both
sides of the isle deserve credit for having authored and supported legislation which could help make
passing on a business easier. These proposals include making the estate tax less burdensome for family
businesses and farms, and making the transition to become an ESOP easier. FBC supports these efforts
while we oppose misguided proposals that would make transitioning to the next generation more
difficult for family businesses like repealing step-up in basis and imposing a new tax on unrealized capital
gains.

Addressing ESOP Transition Challenges

For most family businesses and farms, converting to an ESOP, unfortunately, simply is not within the
realm of possibility. For many larger businesses that have the resources to undergo the transition, the
Employee Stock Ownership Program model (ESOP), can be an attractive option for both owners and
employees. The transition to becoming an ESOP, however, can be complex and costly. The larger
companies we have worked with that made the full transition from pass-through businesses to ESOPs
are generally pleased with the end result but the process to covert can be arduous. One larger business
that we work with ran into a number of complications and costs along the way, including undergoing a
feasibility study, agreeing on a valuation with the trustee, and setting up processes to comply with the
Department of Labor. The entire process took over 18 months. It took nearly two full days just to
complete the mountains of paperwork at closing. The last column and row of Figure 1 shows that the
cost to transition to an ESOP can range between $50,000-$100,000 for a medium sized business.

While ESOP businesses deserve further attention, FBC is principally focused on the fact that most family
businesses are currently organized as pass-through businesses. The main concerns we hear from the
perspective of pass-through businesses include the lack of predictability in tax law, the steep compliance
costs associated with succession planning, and the costs of taxes and regulations that must be accounted
for when building a family business.

Tax Permanence and Small Business Succession

The 2017 Tax Cuts and Jobs Act (TCJA) made important improvements to the tax code for small
businesses, including lowering marginal tax rates that small businesses pay across the board, creating a
new tax deduction for qualifying small business income, and doubling the unified estate, gift, and GST
exemptions. The Family Business Coalition supports making these changes permanent to provide
predictability for family-owned businesses that have been forced to grapple with an ever-changing tax
code over the past 25 years. Constant changes in the tax code affect planning and compliance for family
business owners whose most valuable resource is their time. Being buried in paperwork prevents them
from doing what they do best: creating jobs and serving the communities they are a part of.

Congress is quickly approaching another moment of crisis as most individual side tax relief will expire at
the end of 2025. Expiring tax relief affects the standard deduction, all marginal tax rates, the Section
199A small business tax deduction, the child tax credit, the estate, gift, and generation skipping trust
exemptions, and more. Another last-minute game of chicken between the parties approaching this
deadline is the last thing that small businesses need.

Transfer Taxes Complicate Family Business Succession

When planning to pass their businesses to the next generation, family business owners and farmers
must consider death taxes on both the national and state level. The federal estate tax, commonly
referred to as the “death tax”, presents a potential succession challenge for family businesses, especially
for “inventory or land rich but cash poor” businesses that tend to operate on low margins like family
farms. When a family does not have the cash on hand to pay the estate tax, they may be forced to fire
workers, sell off parts of the business, or in the worst cases close the doors of their family business
permanently.

Larger family businesses that compete with publicly traded corporations may be forced to pay a 40%
death tax at the turn of each generation, but publicly traded corporations effectively self-perpetuate
without the added costs of estate taxes or succession planning. This incongruence in the tax law allows
mega-corporations to swoop in upon the death of a family businesses owner or farmer and buy up these
businesses at fire-sale prices. This trend must be reversed if we hope to prevent Main Street from being
bought by Wall Street.

As family business owners and farmers planning for succession will tell you, annual expenses related to
estate planning and compliance must be accounted for in addition to taxes imposed at death. According
to the non-partisan Tax Foundation, compliance costs related to estate and gift taxes totaled $18.9 billion
in 2023. In 2021, the last year that IRS Statistics of Income (SOI) data is available, collections from estate
taxes totaled only $18.4 billion, less than one half of one percent of federal revenue. These numbers
show that the estate tax costs more to comply with than the government collects annually in estate tax
revenue. Economists from both sides of the isle have written about the inefficiency of raising revenue
through taxes at death.

Complicating the compliance picture for family businesses even more, there are currently 12 states that
impose their own estate taxes and 6 states that impose inheritance taxes. Maryland is the only state to
impose both. These transfer taxes range in scope and severity with some states like Washington state
levying a 20% additional state estate tax. Iowa recently joined the majority of states who no longer levy
additional death taxes, with their state estate tax on a phasing out by 2025. Regarding state transfer
taxes, the Tax Foundation concludes: “Estate and inheritance taxes are burdensome. They disincentivize
investment and can drive high-net-worth individuals out of state. The handful of states that still impose
them should consider gradually eliminating them or at least conforming to federal exemption levels.”
Figure 2, using data from the Tax Foundation and state statues lists the states that currently impose
additional death taxes. These multiple layers of transfer taxes complicate the succession picture even
more for family businesses. Figure 3 shows federal estate tax returns by state over a twenty-year period
from 1995-2015. In Iowa, as an example, nearly $2.4 billion was taken from taxpayers in federal estate
taxes over that period.

Given the massive compliance costs associated with estate and gift taxes, the estate tax’s negative
impact on job growth and the economy, and the tiny amount of revenue that the tax collects, the Family
Business Coalition stands in strong support of Senator Thune and Senator Ernst’s efforts to eliminate the
tax. Our Family Business Coalition’s letter of support for the Death Tax Repeal Act included over 155
signatories from industries across the economy including groups like the Associated Builders and
Contractors, Wine and Spirits Wholesalers, National Association of Electrical Distributors, and more.
Representatives Randy Feenstra (IA-4) and Sanford Bishop (GA-2) recently introduced a bipartisan House
companion bill along with 162 original cosponsors. Ranking Member Ernst deserves credit for continuing
to build consensus on this important issue and move legislation forward in the Senate.

Proposals Making Succession More Difficult

FBC has opposed a number of tax proposals that would make succession more difficult for family
businesses, including eliminating step-up in basis and creating a new tax on unrealized capital gains.

Eliminating step-up in basis would force the current generation to pay capital gains taxes on the entire
appreciation of a family business, even if that appreciation occurred during the lifetime of the previous
owner. Multigenerational farms, ranches, and small businesses that started with little to no basis and
have grown through generations of hard work and sweat equity have the most to lose from this
proposed change. A 2020 study by Texas A&M University showed that 98% of family farms would see a
new tax liability of nearly $730,000 if the step-up in basis rules were to be eliminated.

Imposing a new tax on unrealized gains, annually or at death would compound the difficulty of passing
on a family business or farm to the next generation. Taxing unrealized or phantom gains creates a similar
problem that the estate tax does for family businesses. Families who lack the cash on hand to pay an
annual tax assessed on the value of their estate may be forced to liquidate parts of their family business
to come up with the cash to pay the tax. Tracking and appraising assets annually would create an
administrative nightmare for family businesses and federal agencies alike.

Changing the rules for how family businesses calculate their value for tax purposes and retroactively
changing the rules for trusts has the potential to make void thousands of businesses long-standing
succession plans. Retroactive changes along these lines would pull the rug out from under thousands of
businesses, forcing them to undergo the expensive process of estate planning all over again. Eliminating
step-up in basis, imposing new taxes on unrealized capital gains, and removing the tools family
businesses use the plan for succession will only further tilt the table in favor of large multinational
corporations and lead to further consolidation.

Conclusion

If Congress hopes to improve the chances for family business succession and resist consolidation of
power into the c-suites of large multinational corporations, a comprehensive approach to the problem
must be undertaken. This approach should include better education on the need for estate planning and
meaningful, permanent tax relief for small businesses. FBC looks forward to continuing to work with
both parties in Congress and our 157 partner associations to help America’s family businesses and farms
pass to the generation of ownership. Thank you for calling this important hearing and I look forward to
the discussion here today.
Figure 1: Frequently Used Estate Planning Techniques for Family Businesses and
                            Associated Fees


Estate Planning                      Description                              Range of Fees
   Technique
   Basic estate
    planning
                     Wills, powers of attorney, and living trusts            $5,000-$50,000
   documents

   Basic trusts      Basic trusts established to transfer assets
                     to children and spouses
                                                                             $5,000-$15,000

   Retirement-       Estate planning related to tax-deferred
 benefit planning    retirement plans, such as 401(k) accounts
                                                                             $5,000-$50,000

  Irrevocable life   Creation of ILITs to separate life insurance
 insurance trusts    policies from taxable estates
                                                                             $10,000-$25,000

 Limited Liability   Established to transfer ownership
companies (LLCs)     interests in a family business to
                                                                            $25,000-$250,000
   and Limited       subsequent generations while reducing
   Partnerships      the estate’s interest in the business

 Planning for the    Advanced planning techniques, such as
 disposition of a    stock redemption plans and Employee
                                                                           $50,000-$1,000,000
   closely held      Stock Ownership Plans used to transfer a
     business        business to family members or employees

 Charitable trusts   Estate planning related to the deduction
                     for gifts to charity, providing income to
                                                                            $25,000-$100,000
                     heirs for a limited time

Source: Planning techniques and cost estimates prepared by Michelle Gallagher CPA/ABV/CFF of the
firm Gallagher, Flintoff & Klein, PLC, Lansing, MI, for the Family Business Coalition, January 2024
Figure 2




Source: Tax Foundation, State statues
Figure 3


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